Does High Plains’ accounting treatment of its capital leases and receivable sale lower its earnings quality?

High Plains’ average net operating assets at the end of 2008 and 2007 was $977.89 million and $642.83 million, respectively.

Does High Plains’ accounting treatment of its capital leases and receivable sale lower its earnings quality?
A . Both treatments lower earnings quality.
B . The treatment of capital leases lowers earnings quality.
C . The treatment of the receivables sale lowers earnings quality.

View Answer

Answer: C

Explanation:

A capital lease is reported on the balance sheet as an asset and as a liability. In the income statement, the leased asset is depreciated and interest expense is recognized on the liability. Thus, capitalizing a lease enhances earnings quality. An operating lease lowers earnings quality.

The receivable sale, with recourse, lowers earnings quality. The sale is treated as a collection thereby increasing operating cash flow.

However, High Plains is still responsible to the buyer in the event the receivables are not ultimately collected. Thus, the receivable sale is a collateralized borrowing arrangement that remains orT-balance-sheet. (Study Session 7, LOS 25.d,f)